A History of Financial Panics in the U.S.

Discover how the history of financial panics in the U.S. is also the history of American politics.

Train Through Tunnel

The panic of 1857 resulted from English doubts about whether American railroads had clear title to western lands and whether cash-strapped farmers on railroad land would pay off their mortgages.

Photo By Fotolia/steheap

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From the merchant William Duer’s attempts to speculate on post–Revolutionary War debt, to an ill-conceived 1815 plan to sell English coats to Americans on credit, to the debt-fueled railroad expansion that precipitated the Panic of 1857, A Nation of Deadbeats (Alfred A. Knopf, 2012), by Scott Reynolds Nelson, offers a crash course in the history of financial panics in the U.S. — and a concise explanation of the first principles that caused them all. The following excerpt comes from the preface, “A Republic of Deadbeats.”   

After his first divorce but before he became respectable, my father was a repo man. He did not look the part, which made him all the more effective. He alternately wore a long mustache or a shaggy beard and owned bell-bottoms that were black, blue, and cherry red. His imitation-silk shirts were festooned with city maps, or cartoon characters, or sailing ships. Dad sang in the car, at the top of his lungs, mostly obscure show tunes. His white Dodge Dart had “Mach 1” racing stripes that he had lifted from a souped-up Ford Mustang. The “deadbeats” saw him coming, that’s for sure, but they did not understand his profession until he walked into their homes and took away their televisions.

A deadbeat, Dad told me, “was a guy whose mouth wrote a check his ass could not cash.” They might be rich or poor, young or old, male or female, black or white, but “deadbeat” was written all over them, and my dad could read it. Florida’s Orange, Seminole, and Volusia Counties had plenty of them. And when Dad was working for Woolco, the department store, Woolco got its goods back. Woolco lent appliances to people on the installment plan, and when they failed to pay, ignored the letters and phone calls, refused to answer the door, my father would come by. He often posed as a meter reader or someone with a broken-down car. If he saw a random object lying abandoned in the yard, he would pick it up and bring it to the door as if he were returning it. He was warm and funny, charming, but pushy. He did not carry a gun, but he was fearless under pressure and impervious to verbal abuse. He was earnest about the return of the goods. If the door opened, he was inside; if he was inside, he shortly had his hands on the appliance; the rest was bookkeeping.

As you can imagine, repo men like my father saw people at their worst. He told me that central Florida was full of deadbeats — people who borrowed and borrowed, then lied, hid from their debts, pretended they were solvent, until the guy in bell-bottoms arrived.

My dad was not inclined to be generous about how people got to this place. His own career in repossession began in late 1973, after the first oil shock brought minor financial catastrophe to central Florida. Dad, in fact, had lost a very good job as a regional sales manager at Kimberly-Clark. Repo man was a sudden and severe step down, but there were debts to pay. At the end of 1973, many central Florida families were drowning in consumer debt they had contracted when times were brighter. In this downturn these people certainly had “skin in the game,” and it was my dad who did the skinning.

In a certain sense, the story of my dad, Woolco’s debtors, and the debts he collected is the story of American history. Americans settled this nation by borrowing goods, land, and more abstract representations of those goods — land warrants, deeds, patents, concessions, and equities. They borrowed with the most optimistic assumptions about their capacity to pay. But when it became clear that Americans were not paying, banks began to doubt wholesalers and called in loans; wholesalers demanded settlement from retailers; retailers sent my dad and thousands like him out into the countryside to recall some portion of their property. Times got hard.

Pundits will tell you that the economic turmoil the nation experienced in 2008-2009 was the first “consumer debt” crash, built on junk consumer debt. These debts were in turn packed into “collateralized debt obligations,” or CDOs, paper representations of debt that could be bought and sold as financial instruments. CDOs, we are told, weakened the overall economy by dressing up bad loans as good ones. In 2005 or so, a banker who dealt in junk debt allegedly said: “Give me shit, a blender, and lots of sugar and I will make you a chocolate mousse.” In 2008, banks began to figure out just what was in these CDOs. A banking crisis began that brought down multibillion-dollar banking giants like Bear Stearns and Lehman Brothers, as well as causing devastating financial shocks for the thousands of midsized banks and pension funds around the world that held this toxic debt. The federal government, the European Central Bank, and other international government agencies paid for a bailout that has so far cost more than $3 trillion.

The trunk of my father’s Dodge Dart suggests that this story of bad debts was not new. In fact, America has seen numerous periods of similar financial decline, and in most cases consumer debt lay at the heart of it. My dad understood consumer debt intimately; tucked back in his trunk was an accordion file filled with photocopies of signed loan agreements for everyday items such as toaster ovens and stereos. These agreements had allowed Woolworth, the parent company of Woolco, to borrow cash repeatedly. Consumer debt had been the source of Woolworth’s equity — the basis for Woolworth stocks, for its bonds, for the credit that stereo manufacturers and cosmetics companies provided, and for Woolworth’s numerous bank credit lines. All of it rested on documents like the agreements in Dad’s trunk, and most of those debts, he said, were good for nothing.

Many economists and historians have written about past American depressions, panics, and crashes. From the 1880s to the 1950s, these scholars have told the history of the nation’s economic downturns as the history of banks. This approach was not entirely wrong, but it tended to focus on big personalities or New York institutions. It tended to ignore the farmers, artisans, slaveholders, shopkeepers, and wholesalers whose borrowing had fueled the booms and busts. Then, in the 1960s and 1970s, the so-called New Economic Historians (or “cliometricians”) came along with a different story. Using state and federal data, they tried to build simple mathematical models of the nation’s financial health. Moving beyond the saga in which banks played the central role, they emphasized what they termed the “real economy,” by which they meant measurable indices of growth and profit. Unfortunately, they tended to analyze the data from thirty-five thousand feet, creating a seemingly coherent picture of the entire American economy out of published numbers that were much hazier when viewed up close. These economists sought to estimate such variables as the nation’s gross domestic product, its gross income, and its collective return on investment, but none of these figures had been measured directly before the 1930s, and the cliometricians’ projections of this data into the past were all based on approximations.

But these models, however scientific they looked, tended to be abstract representations of an economy that was, in fact, more complex and more interconnected than can be predicted or explained with a linear model of inputs and outputs. They tended, for example, to assume that old banks were like modern banks, sharing common accounting principles, or that because banks first issued credit cards in the 1960s, banks had no consumer credit before then. The cliometricians’ work was thus often ahistorical. They drilled into historical documents looking for seemingly relevant numbers, then plugged those numbers into a model of a world they understood rather than the economy they sought to describe. And they tended to ignore things that weren’t measurable, like hope.

Seldom did these accounts reflect the reality that my dad wrestled with every day: how optimistic assumptions had again and again led Americans to buy millions of shiny new things, and how significant factors outside the banking narrative, such as high commodity prices (oil in Dad’s day) and lost jobs (in ours), had turned dreamers into defaulters. In fact, the only panic in which American consumer debt did not figure much was the Great Depression of the 1930s, the only crash that most economists understand.

But as I’ll show in the chapters that follow, the nation saw significant economic declines in 1792, 1819, 1837, 1857, 1873, 1893, and 1929. The question in each of these panics boiled down to one my dad well understood. European lenders wondered if Americans would honor their financial promises, or was America simply a nation of deadbeats? That question has been crucial to understanding the history of financial panics in the U.S., though most observers have missed it.

For despite the cliometricians’ emphasis on the American economy’s vital statistics as an indicator of economic health, panics have always crossed oceans. Panics are always and everywhere transnational because credit is transnational. Panic comes from one nation’s doubts about another nation’s capacity to pay. Were Americans particularly incapable of paying their debts? King George III thought so when he sent Hessian troops to put down the heavily indebted merchants and farmers of Boston and Virginia in the American Revolution. The French revolutionary assembly had its doubts when the Americans refused to reimburse it for the French navies that had rescued them at Yorktown. The first panic in 1792 had everything to do with foreign lenders’ doubts about Americans’ ability to subdue western Indians who blocked westward expansion. Recovery came when European investors judged New England smugglers to be safer borrowers than French revolutionary assemblies or Saint Domingue slaveholders and put their money back into American banks.

The pattern would continue throughout the nineteenth century. An economic boom after 1815 was conceived in a scheme to sell English woolen coats to Americans on credit. The panic came in 1819 when trade negotiations between America and Britain failed, causing Americans to lose their best trading partners. In the 1830s, British banks with too much cash bet on a speculative bubble in American cotton plantations; British and American banks busted when the Bank of England doubted slave owners’ ability to pay. The panic of 1857 resulted from English doubts about whether American railroads had clear title to western lands and whether cash-strapped farmers on railroad land would pay off their mortgages. And while cheap exports from American farmers contributed to the international panic of 1873, the crash started in Vienna and sloshed onto American shores when the Bank of England raised interest rates. The panic of 1893 was largely a byproduct of a sudden drop in sugar-tax revenues from Cuba, and it climaxed when Europeans doubted if American borrowers would repay their debts in gold. Finally, in 1928, Americans’ doubts about dollar loans to consumers in Germany and Latin America seized up international bond markets and laid the groundwork for the crash of 1929 and the Depression that followed.

In each case, the documents stored away for safekeeping — whether a promissory note or a bill of exchange, bank draft, or railway bond — were viewed as assets by financial intermediaries: merchant banks, banks of deposit, brokers, moneylenders, and insurance companies.Other financial intermediaries involved may be unfamiliar — the Federal Land Office, New York wholesalers, midwestern railways, and Albany insurance companies, among others — but in each case these financial intermediaries convinced themselves that the financial instrument they had created was sophisticated enough to protect them from consumer default. And in each case the complex chain of institutions linking borrowers and lenders made it impossible for lenders to distinguish good loans from bad.

In those crashes in America’s past, perhaps a repo man in a Dodge Dart with a million gallons of gas could have visited every debtor, edged his way in, and decided who was good for it. But lenders have neither the time nor the capacity to act with the diligence of a repo man. Instead, lenders (let’s agree to call all of them banks) try to unload the debts, hide from their own creditors, go into bankruptcy, and call on state and federal institutions for relief. But banks, as we will see, have routinely overestimated the collateral — the underlying asset — for the loans they hold. When those debts go unpaid or appear unpayable, banks quickly withdraw lending; the teller’s window slams shut. As banks suspend lending, a crisis on Wall Street becomes a crisis on Main Street. Money is tight. Loans are impossible: crash.

Besides exploring what caused these panics, I’ll consider here what changes these panics caused. Unlike Karl Marx, I do not believe that all human actions are dictated by economic catastrophes, but it turns out that panics have changed a lot of things in American history. Marx predicted that workers and farmers would organize in crises. In fact, they usually formed unions during economic booms. Unions like the Brotherhood of Locomotive Engineers, the Knights of Labor, and the American Federation of Labor, for example, all organized during financial upswings.

When busts came, the rules of politics changed as strong political figures emerged who courted farmers, artisans, sailors, and soldiers burned by financial disaster. Many Americans switched parties, since the people in power usually took the blame. Thus in 1793 a political faction appealed to artisans and farmers hurt by that panic; they organized a new party. Labeled “Democrats” by their opponents, they had obtained almost complete hegemony by 1800. In the aftermath of the financial downturn of 1819, the Democratic Party splintered, with the Jacksonian wing ultimately absorbing those with concrete grievances about the economy. After the panic in 1837 wrecked Jackson’s party and boosted the newly formed Whigs, the seesawing continued: The 1857 panic caused northern and especially midwestern voters to abandon the Democratic Party for the Republicans, while the crash of 1873 led voters back to the Democrats. After 1893, the wind shifted again as many voters blamed Democrats for hard times. At the same time, both parties saw reform wings within their ranks build a movement called Progressivism. Finally, in 1929, many traditional Republican voters abandoned their party, while a divided Democratic Party found a common theme in reform. The story of American financial panics is the story of politics.

While some parts of this political story may sound familiar, I’d suggest that financial and political history is woven together in ways that are difficult to see at first glance. The First and Second Banks of the United States, the Suffolk Bank of Massachusetts, and the New York Clearing House were all central banks, but they were also political organizations, often covertly intervening in state and federal elections. Criticism of these institutions by Jefferson, Jackson, Roosevelt, Wilson, Hoover, FDR, and others was not just paranoid delusion (though Jackson’s paranoia must never be overlooked). Politicians and everyday citizens later exposed how these institutions corrupted American politics. It was not just hyperbole to refer to these banks as political machines. As we shall see, they often were.

I’ll also examine here the changes in daily life that panics wrought. For example, controversies over liquor often increased after economic downturns. In the wake of the 1792 panic, for instance, a new tax on alcohol led the whiskey rebels to take up arms against the federal government. After 1819, Philadelphia hospitals received so many out-of-work alcoholics that they learned to plot out the stages of alcohol withdrawal, giving us the medical term “delirium tremens.” While the Whigs came to power after 1837 on a campaign of “hard cider,” the 1857 panic saw the collapse of an anti-liquor party called the Know-Nothings. The fallout from the panic of 1873 led to the rise of new criminal enterprises built on gambling and liquor in Chicago, while after the 1893 panic the federal government implemented a new tax on liquor to recover lost federal revenue. A constitutional amendment prohibited the sale of alcohol after World War I, but Democrats overturned it, hoping a beer tax would help end the financial crisis of the 1930s. We can also credit financial panics with the creation of the presidential cabinet meeting, the founding of the New York Stock Exchange, the rise of Mormonism, and the invention of the self-service grocery. To talk about the history of panic attacks in the Unites States is to talk about a novel about whales, a guerrilla war over the plains of Kansas, and the invention of the jukebox.

My father died before this book was written, but it is nonetheless my side of a thirty-year-long argument with him. Not surprisingly, he disliked deadbeats, seeing them as the people whose false promises weakened this country. He probably had a point, and no doubt the executives of Woolco would agree. But I find much in them to admire, for defaulters are often dreamers. In viewing America’s financial panics through the lens of numerous unfulfilled and forgotten debts that even the oldest banker cannot possibly remember, I hope to provide a perspective my dad would have appreciated: the view from the front porch, the minute he rang the doorbell, when both debtor and creditor prepared their stories.

This excerpt has been reprinted with permission from A Nation of Deadbeats: An Uncommon History of America’s Financial Disasters, published by Alfred A. Knopf, 2012.